Thursday, March 11, 2010

Spring Break

I watch the television show Lost and each week it begins the same way. A serious voice intones “Previously – on Lost” and the station then runs through some clips of what happened the week before so that audience members can get back up to speed before the new action begins.

My students are on Spring Break this week and, although I might dream that they are studying financial accounting, I imagine that few are. They were doing great right before Spring Break but they will have been away from the subject matter for 10 days by the time I see them again next Monday. We had done a lot of good work on the reporting of inventory but it is likely that much of that information is now jello knowledge (a term from an earlier post).

So, next Monday, I will start out with my version of “Previously – in reporting inventory” and try to get them back up and running as quickly as possible. I will do this by starting out with a series of quick questions designed to rebuild the knowledge that may have slipped away. These are reminder questions. There is no new information here. That is not the point. However, I don’t want to simply tell them the information again. They would just fall into their stenographer mode and start copying down notes.

Instead, I start asking people these quick questions designed to “remind” them of what they already know. Here are the questions that I will ask on Monday (as well as the expected answers). They may not get every question right immediately but I would expect that, in ten minutes, we will be up and running.

(Do note that I teach both periodic and perpetual inventory systems. I have friends who question the inclusion of periodic inventory because it is “antiquated.” My response is that a lot of small businesses such as beauticians, kennels, barber shops, restaurants, health spas, and the like still use periodic inventory. Despite the wide scale availability of computers, it is not an obsolete system. More importantly, I think working with the cost of goods sold formula of beginning inventory plus purchases less ending inventory helps students better visualize the interconnected relationship of ending inventory and cost of goods sold.)

“Previously—in reporting inventory”1 – If you look at a balance sheet and see $124,889 reported for inventory, what are you seeing? (The lower of the inventory cost or its market value.)2 – What is included in the cost of inventory? (Any amount that was incurred which was normal and necessary to get the inventory item into position and condition to be sold.)3 – What is the difference in a periodic and perpetual inventory system? (A periodic system does not maintain a record of either the current inventory or cost of goods sold whereas a perpetual system does.)4 – What are the advantages of a periodic inventory system and a perpetual inventory system? (A periodic system is very cheap to maintain while a perpetual system provides up to date financial information about the inventory on hand and the amount that has been sold this period.)5 – When inventory is bought, what entry is made in a periodic system? In a perpetual system? (“Purchases” is debited in a periodic system so that a record of the cost incurred is maintained. “Inventory” is debited in a perpetual system so that the current asset balance is available.)6 – What entry is made at the point of sale in connection with inventory? (In a periodic system, no entry is made because balances are not maintained. The cost is not known. In a perpetual system, cost of goods sold is debited and inventory is credited.)7 – In a periodic system, no entry is made to record the cost of goods sold when a sale is made. How then is cost of goods sold determined for reporting purposes? (A physical inventory count is taken and cost of goods sold is calculated by formula: beginning inventory plus purchases less ending inventory equals cost of goods sold.)8 – When is the physical inventory count taken? (In a periodic system, the count is made at the end of the reporting period so that the asset balance and cost of goods sold can be determined. In a perpetual system, the count is normally made at some convenient time to ensure the accuracy of the accounting records. In a perpetual system, a year-end count is not needed unless the accuracy of the records is questioned.)9 – When is a cost flow assumption such as LIFO and FIFO needed? (A cost flow assumption is needed whenever a company holds inventory items that were bought at different costs. If the costs are all the same, a cost flow assumption is not necessary.)10 – When is a cost flow assumption actually used in a perpetual inventory system? (In a perpetual system, the cost flow assumption is used at the time of each sale to determine which cost is moved from inventory to cost of goods sold.) 11 – When is a cost flow assumption actually used in a periodic inventory system? (In a periodic system, the cost flow assumption is needed after the physical inventory is taken in order to determine the cost of those items. When the resulting cost of the ending inventory is entered into the cost of goods sold formula, it creates the assumed pattern in arriving at the expense.)12 – An item is bought for $10 on Monday and a second identical one is bought for $11 on Tuesday. One is sold on Wednesday. Which item was sold? (We don’t know and we don’t care. We are not trying to determine the identity of a sold unit. Instead, we are trying to decide which cost should stay in the inventory ledger account and which cost should be moved to cost of goods sold. That is why we call FIFO and LIFO “cost flow assumptions.” We are making an assumption about the movement of the cost.)13 - An item is bought for $10 on Monday and a second identical one is bought for $11 on Tuesday. One is sold on Wednesday. Which cost is moved from inventory to cost of goods sold? (If FIFO is the cost flow assumption, it is the $10 [the first cost] that moves to cost of goods sold. If LIFO is the cost flow assumption, it is the $11 [the last cost] that moves to cost of goods sold.

Okay, there are 13 lucky questions here that I will ask my students at the start of class on Monday. Hopefully, there is nothing in these questions that they cannot get pretty quickly. After about 10 minutes, they should be back up to speed (hopefully) and ready to move into new territory.